-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JrTbNZSOYeElexopX2Qy2M1YzAwwlHeE9LtzXbtl7RIDXskssU6qwJXUequqQ9O1 L8RYCGJx4JFVmK4t8Gdauw== 0000950135-99-004017.txt : 19990816 0000950135-99-004017.hdr.sgml : 19990816 ACCESSION NUMBER: 0000950135-99-004017 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONCORD COMMUNICATIONS INC CENTRAL INDEX KEY: 0000915290 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 042710876 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-23067 FILM NUMBER: 99687686 BUSINESS ADDRESS: STREET 1: 600 NICKERSON RD CITY: MARLBORO STATE: MA ZIP: 01752 BUSINESS PHONE: 508-460-4646 MAIL ADDRESS: STREET 1: 600 NICKERSON RD CITY: MARLBORO STATE: MA ZIP: 01752 10-Q 1 CONCORD COMMUNICATIONS 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ to ______________ COMMISSION FILE NUMBER 0-23067 CONCORD COMMUNICATIONS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MASSACHUSETTS 04-2710876 (State of incorporation) (IRS Employer Identification Number) 600 NICKERSON ROAD MARLBORO, MASSACHUSETTS 01752 (508) 460-4646 (ADDRESS AND TELEPHONE OF PRINCIPAL EXECUTIVE OFFICES) ---------------- INDICATE BY CHECK MARK WHETHER REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS, AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO 13,452,167 SHARES OF THE REGISTRANT'S COMMON STOCK, $0.01 PAR VALUE, WERE OUTSTANDING AS OF JUNE 30, 1999. THIS DOCUMENT CONTAINS 20 PAGES. THE EXHIBIT INDEX IS ON PAGE 21. 2 CONCORD COMMUNICATIONS, INC. FORM 10-Q, JUNE 30, 1999 CONTENTS Item Number Page PART I: FINANCIAL INFORMATION Item 1. Financial Statements Balance sheets: June 30, 1999 and December 31, 1998 3 Statements of operations: Three and six months ended June 30, 1999 and June 30, 1998 4 Statements of cash flows: Six months ended June 30, 1999 and June 30, 1998 5 Notes to financial statements 6-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-18 Item 3. Quantitative and Qualitative Disclosures about Market Risk 18 PART II: OTHER INFORMATION Item 1. Legal Proceedings 19 Item 2. Changes in Securities and Use of Proceeds 19 Item 3. Defaults Upon Senior Securities 19 Item 4. Submission of Matters to a Vote of Security Holders 19 Item 5. Other Information 19 Item 6. Exhibits and Reports on Form 8-K 19 SIGNATURE 20 EXHIBIT INDEX 21 2 3 PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONCORD COMMUNICATIONS, INC. BALANCE SHEETS
JUNE 30, DECEMBER 31, 1999 1998 -------- ------------ ASSETS Current Assets: Cash and cash equivalents............................. $ 7,912,709 $ 11,164,349 Marketable securities................................. 51,103,539 39,237,680 Accounts receivable, net of allowance of approximately $590,000 and $450,000, respectively................. 7,115,784 5,048,879 Prepaid expenses and other current assets............. 607,601 509,805 ----------- ------------ Total current assets.............................. 66,739,633 55,960,713 ----------- ------------ Equipment and Improvements, at cost: Equipment............................................. 4,844,091 3,701,266 Leasehold improvements................................ 1,949,254 385,128 ----------- ------------ 6,793,345 4,086,394 Less-- Accumulated depreciation and amortization...... 2,024,493 1,365,222 ----------- ------------ 4,768,852 2,721,172 ----------- ------------ $71,508,485 $ 58,681,885 =========== ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable...................................... $ 4,928,833 $ 3,553,673 Accrued expenses...................................... 5,735,000 4,086,983 Deferred revenue...................................... 6,489,417 5,296,469 ----------- ------------ Total current liabilities......................... 17,153,250 12,937,125 ----------- ------------ Stockholders' Equity Preferred stock, $.01 par value -- Authorized -- 1,000,000 shares no shares issued and outstanding -- -- Common stock, $.01 par value-- Authorized -- 50,000,000 shares Issued and outstanding -- 13,376,768 and 13,040,374 shares, respectively................................ 133,768 130,405 Additional paid-in capital............................ 74,201,893 69,938,129 Deferred compensation................................. (77,205) (101,189) Accumulated comprehensive income...................... (733,545) 149,606 Accumulated deficit................................... (19,169,676) (24,372,191) ----------- ------------ Total stockholders' equity ....................... 54,355,235 45,744,760 ----------- ------------ $71,508,485 $ 58,681,885 =========== ============
The accompanying notes are an integral part of these financial statements. 3 4 CONCORD COMMUNICATIONS, INC. STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED ---------------------------------------------------------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1999 1998 1999 1998 -------- -------- -------- -------- Revenues: License revenues............. $ 11,877,074 $ 7,104,600 $ 22,857,164 $ 13,204,591 Service revenues............. 3,184,241 1,435,864 5,732,683 2,395,920 ------------- ------------- ------------- ------------- Total revenues.......... 15,061,315 8,540,464 28,589,847 15,600,511 Cost of Revenues.................. 1,853,521 998,720 3,524,469 1,852,259 ------------- ------------- ------------- ------------- Gross profit............ 13,207,794 7,541,744 25,065,378 13,748,252 ------------- ------------- ------------- ------------- Operating Expenses: Research and development..... 2,469,165 1,711,725 4,625,795 3,215,367 Sales and marketing.......... 6,309,725 3,938,812 11,907,098 7,446,108 General and administrative... 795,533 594,122 1,598,366 1,166,818 ------------- ------------- ------------- ------------- Total operating expenses..... 9,574,423 6,244,659 18,131,259 11,828,293 ------------- ------------- ------------- ------------- Operating income........ 3,633,371 1,297,085 6,934,119 1,919,959 ------------- ------------- ------------- ------------- Other Income (Expense): Interest income.............. 749,384 554,394 1,465,451 1,104,814 Interest expense............. -- -- -- (514) Other........................ 1,650 974 (9,055) (39,541) ------------- ------------- ------------- ------------- Total other income...... 751,034 555,368 1,456,396 1,064,759 ------------- ------------- ------------- ------------- Income before income taxes.................. 4,384,405 1,852,453 8,390,515 2,984,718 Provision for income taxes... 1,666,000 -- 3,188,000 -- ------------- ------------- ------------- ------------- Net income.............. $ 2,718,405 $ 1,852,453 $ 5,202,515 $ 2,984,718 ============= ============= ============= ============= Net income per common and potential common share: Basic $ 0.20 $ 0.15 $ 0.39 $ 0.24 ============= ============= ============= ============= Diluted $ 0.19 $ 0.13 $ 0.36 $ 0.21 ============= ============= ============= ============= Weighted average common and potential common shares outstanding: Basic 13,339,718 12,565,017 13,247,441 12,395,448 ============= ============= ============= ============= Diluted 14,277,330 13,982,741 14,313,815 13,960,730 ============= ============= ============= =============
The accompanying notes are an integral part of these financial statements. 4 5 CONCORD COMMUNICATIONS, INC. STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED ----------------------------------- JUNE 30, JUNE 30, 1999 1998 -------- -------- Cash Flows from Operating Activities: Net income $ 5,202,515 $ 2,984,718 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization (199,895) 380,415 Changes in current assets and liabilities Accounts receivable (2,066,906) 28,478 Prepaid expenses and other current assets (97,796) (81,407) Accounts payable 1,375,160 905,093 Accrued expenses 1,648,017 (691,236) Deferred revenue 1,192,948 750,435 ----------- ----------- Net cash provided by operating activities 7,054,043 4,276,496 ----------- ----------- Cash Flows from Investing Activities: Purchases of marketable securities (72,119,908) (25,628,502) Sales of marketable securities 60,254,049 18,266,229 Purchases of equipment and improvements (2,706,951) (861,122) ----------- ----------- Net cash used in investing activities (14,572,810) (8,223,395) ----------- ----------- Cash Flows from Financing Activities: Proceeds from exercise of stock options 4,267,127 515,865 ----------- ----------- Net Decrease in Cash and Cash Equivalents (3,251,640) (3,431,034) Cash and Cash Equivalents, beginning of period 11,164,349 7,858,186 ----------- ----------- Cash and Cash Equivalents, end of period $ 7,912,709 $ 4,427,152 =========== =========== Supplemental Disclosure of Cash Flow Information: Cash paid for taxes $ 151,050 $ -- =========== =========== Supplemental Disclosure of Noncash Transactions: Unrealized (loss) gain on available-for-sale securities $ (883,151) $ 26,393 =========== =========== Tax benefit associated with employee stock options $ 3,000,000 $ -- =========== =========== Retirement of fully depreciated fixed assets $ -- $ 4,330,000 =========== ===========
The accompanying notes are an integral part of these financial statements. 5 6 CONCORD COMMUNICATIONS, INC. NOTES TO FINANCIAL STATEMENTS FORM 10-Q, JUNE 30, 1999 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1. INTERIM FINANCIAL STATEMENTS The accompanying financial statements have been presented by Concord Communications, Inc., (the "Company") without audit (except that the balance sheet information as of December 31, 1998 has been derived from audited financial statements) in accordance with generally accepted accounting principles for interim financial statements and with the instructions to Form 10-Q and Regulation S-X pertaining to interim financial statements. Accordingly, these interim financial statements do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. The financial statements reflect all adjustments and accruals which management considers necessary for a fair presentation of financial position as of June 30, 1999 and December 31, 1998, and results of operations for the three and six months ended June 30, 1999 and 1998. The results for the interim periods presented are not necessarily indicative of results to be expected for any future period. The financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Company's 1998 Annual Report on Form 10-K filed with the Securities and Exchange Commission in March 1999. 2. NET INCOME PER SHARE The Company follows the provisions of SFAS No. 128, Earnings Per Share, effective December 15, 1997. SFAS No. 128 establishes standards for computing and presenting earnings per share and applies to entities with publicly held common stock or potential common stock. The dilutive effect of potential common shares for the six months ended June 30, 1999 and June 30, 1998, consisting of outstanding stock options, is determined using the treasury method. Calculations of basic and diluted net income per common share and potential common share are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED ------------------ ---------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1999 1998 1999 1998 -------- -------- -------- -------- Net income............................ $ 2,718,405 $ 1,852,453 $ 5,202,515 $ 2,984,718 ============ ============ ============ ============ Weighted average common shares outstanding......................... 13,339,718 12,565,017 13,247,441 12,395,448 Potential common shares pursuant to stock options............................. 937,612 1,417,724 1,066,374 1,565,282 ------------ ----------- ------------ ------------ Diluted weighted average shares...... 14,277,330 13,982,741 14,313,815 13,960,730 ============ =========== ============ ============ Basic net income per common share..... $ 0.20 $ 0.15 $ 0.39 $ 0.24 ============ =========== ============ ============ Diluted net income per common and potential common share......... $ 0.19 $ 0.13 $ 0.36 $ 0.21 ============ =========== ============ ============
3. COMPREHENSIVE INCOME The Company follows the provisions of SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The statement is effective for fiscal years beginning after December 15, 1997 and the Company has adopted the statement in its quarter ended March 31, 1998. Comprehensive income for the three and six months ended June 30, 1999 and 1998 is as follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- --------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Net income $ 2,718,405 $ 1,852,453 $ 5,202,515 $ 2,984,718 Unrealized (loss) gain on marketable securities (557,083) 19,679 (883,150) 26,393 ------------ ------------ ------------ ------------ Comprehensive income $ 2,161,322 $ 1,832,774 $ 4,319,365 $ 2,958,325 ============ ============ ============ ============
6 7 4. COMMITMENTS In March, 1999 the Company signed a 7 year operating lease for their principal operating facilities. Aggregate rental payments under the lease will be $12.0 million. 5. TAX PROVISION The Company has recorded a tax provision of $3.2 million in the six months ended June 30, 1999, based on its effective tax rate for 1999, computed in accordance with SFAS No. 109, Accounting for Income Taxes. Pursuant to SFAS No. 109, the Company has recorded the tax benefit associated with the exercise and subsequent disqualifying disposition of incentive stock options by the Company's employees (approximately $3.0 million) as a component of additional paid in capital. 7 8 CONCORD COMMUNICATIONS, INC. FORM 10-Q, JUNE 30, 1999 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company develops, markets and supports a family of turnkey, automated, scalable, Web-based performance analysis and reporting solutions for the management of computer networks. Substantially all of the Company's revenues are derived from the Network Health product family which began shipping in the first quarter of 1995. The Company does not provide forecasts of its future financial performance. From time to time, however, the information provided by the Company or statements made by its employees may contain forward looking statements. In particular, some statements contained in this Form 10-Q and the Company's Annual Report and Form 10-K, for the fiscal year ended December 31, 1998, are not historical statements (including, but not limited to, statements concerning the plan and objectives of management; increases in sales and marketing, research and development and general and administrative expenses; expenses associated with Year 2000 and the Company's expected liquidity and capital resources). This document contains forward looking statements. Any statements contained herein that do not describe historical facts are forward looking statements. The Company makes such forward looking statements under the provisions of the "safe harbor" section of the Private Securities Litigation Reform Act of 1995. The forward looking statements contained herein are based on current expectations, but are subject to a number of risks and uncertainties. The facts that could cause actual results to differ materially from current expectations include the following: risks of intellectual property rights and litigation, risks in technology development and commercialization, risks in product development and market acceptance of and demand for the Company's products, risks of downturns in economic conditions generally, and in the software, networking and telecommunications industries specifically, risks associated with competition and competitive pricing pressures, risks associated with international sales and other risks detailed in the Company's filings with the Securities and Exchange Commission. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain financial data as percentages of the Company's total revenue:
THREE MONTHS ENDED SIX MONTHS ENDED ------------------ ----------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 1999 1998 1999 1998 -------- -------- -------- -------- Revenues: License revenues 78.9% 83.2% 79.9% 84.6% Service revenues 21.1% 16.8% 20.1% 15.4% -------------------------------------------------------------------------- Total revenues 100.0% 100.0% 100.0% 100.0% Cost of revenues 12.3% 11.7% 12.3% 11.9% -------------------------------------------------------------------------- Gross profit 87.7% 88.3% 87.7% 88.1% Operating expenses: Research and development 16.4% 20.0% 16.2% 20.6% Sales and marketing 41.9% 46.1% 41.6% 47.7% General and administrative 5.3% 7.0% 5.6% 7.5 % -------------------------------------------------------------------------- Income from operations 24.1% 15.2% 24.3% 12.3% -------------------------------------------------------------------------- Other income, net 5.0% 6.5% 5.1% 6.8% -------------------------------------------------------------------------- Income before income taxes 29.1% 21.7% 29.4% 19.1% -------------------------------------------------------------------------- Provision for income taxes 11.1% -- 11.2% -- -------------------------------------------------------------------------- Net income 18.0% 21.7% 18.2% 19.1% --------------------------------------------------------------------------
8 9 REVENUES. The Company's revenues consist of software license revenues and service revenues. Software license revenues are recognized in accordance with the American Institute of Certified Public Accountants' Statement of Position ("SOP") 97-2, Software Revenue Recognition. Under SOP 97-2, software license revenues are recognized upon execution of a contract and delivery of software, provided that the license fee is fixed and determinable, no significant production, modification or customization of the software is required and collection is considered probable by management. In 1999, software license revenues are recognized in accordance with SOP 97-2, as modified by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition with respect to Certain Transactions. Service revenues are recognized as the services are performed. Maintenance revenues are derived from customer support agreements generally entered into in connection with initial license sales and subsequent renewals. Maintenance revenues are recognized ratably over the term of the maintenance period. Payments for maintenance fees are generally made in advance. INTERNATIONAL REVENUES. The Company recognized $2.8 million and $1.3 million of revenues from international locations in the three months ended June 30, 1999 and 1998, representing 18.7% and 14.9% of total revenues, respectively. The Company recognized $5.0 million and $2.4 million of revenues from international locations in the six months ended June 30, 1999 and 1998, representing 17.5% and 15.5% of total revenues, respectively. The Company's revenues from international locations were primarily generated from customers located in Europe. Revenues from customers located in Europe accounted for 14.9% and 8.9% of total revenues in the three months ended June 30, 1999 and 1998, respectively. Revenues from customers located in Europe accounted for 13.8% and 11.5% of total revenues in the six months ended June 30, 1999 and 1998, respectively. The continued increase in revenues from international locations is primarily the result of the Company's expansion of its operations outside the United States which has included both the hiring of additional personnel as well as the establishment of additional reseller agreements. The Company believes that continued growth and profitability will require further expansion of its sales in international markets. The Company expects to commit additional time and development resources to customizing its products and services for selected international markets. TOTAL REVENUES. The Company's total revenues increased 76.4% to $15.1 million in the three months ended June 30, 1999 from $8.5 million in the three months ended June 30, 1998. The Company's total revenues increased 83.3% to $28.6 million in the six months ended June 30, 1999 from $15.6 million in the six months ended June 30, 1998. LICENSE REVENUES. The Company's license revenues are derived from the licensing of software products. License revenues increased 67.2% to $11.9 million, or 78.9% of total revenues, in the three months ended June 30, 1999 from $7.1 million, or 83.2% of total revenues, in the three months ended June 30, 1998. License revenues increased 73.1% to $22.9 million, or 79.9% of total revenues, in the six months ended June 30, 1999 from $13.2 million, or 84.6% of total revenues, in the six months ended June 30, 1998. The increase in license revenues resulted from increased sales to new customers and additional sales to existing customers for new products and upgrades of existing licenses. SERVICE REVENUES. The Company's service revenues consist of fees for maintenance, training and professional services. Service revenues increased 121.7% to $3.2 million, or 21.1% of total revenues, in the three months ended June 30, 1999 from $1.4 million, or 16.8% of total revenues, in the three months ended June 30, 1998. Service revenues increased 139.3% to $5.7 million, or 20.1% of total revenues, in the six months ended June 30, 1999 from $2.4 million, or 15.4% of total revenues, in the six months ended June 30, 1998. The increase in service revenues was attributed to an increase in revenue from maintenance contracts, training and professional services for new and existing customers. COST OF REVENUES. Cost of revenues includes expenses associated with royalty costs, production, fulfillment and product documentation, along with personnel costs associated with providing customer support in connection with maintenance and professional service contracts. Royalty costs are comprised of third party software costs. Cost of revenues increased 85.6% to $1.9 million, or 12.3% of total revenues, in the three months ended June 30, 1999 from $999,000, or 11.7% of total revenues, in the three months ended June 30, 1998, resulting in gross margins of 87.7% and 88.3% in each respective period. Cost of revenues increased 90.2% to $3.5 million, or 12.3% of total revenues, in the six months ended June 30, 1999 from $1.9 million, or 11.9% of total revenues, in the six months ended June 30, 1998, resulting in gross margins of 87.7% and 88.1% in each respective period. The increase in cost of revenues in absolute dollars was primarily the result of increased spending in customer support to be more responsive to a growing customer base. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses consist primarily of personnel costs associated with software development. Research and development expenses increased 44.2% to $2.5 million, or 16.4% of total 9 10 revenues, in the three months ended June 30, 1999 from $1.7 million, or 20.0% of total revenues, in the three months ended June 30, 1998. Research and development expenses increased 43.8% to $4.6 million, or 16.2% of total revenues, in the six months ended June 30, 1999 from $3.2 million, or 20.6% of total revenues, in the six months ended June 30, 1998. The increase in absolute dollars was primarily due to the use of outside contractors for consulting and recruiting along with increased headcount in research and development from 43 to 58 for the period from June 30, 1998 to June 30, 1999. The Company's product architecture and higher revenue base have allowed the Company to introduce new products at lower incremental costs thereby reducing research and development expenses as a percentage of revenues. The Company anticipates that it will continue to commit substantial resources to research and development in the future and that product development expenses may increase in absolute dollars in future periods. SALES AND MARKETING EXPENSES. Sales and marketing expenses consist primarily of salaries, commissions to sales personnel and agents, travel, tradeshow participation, public relations, advertising and other promotional expenses. Sales and marketing expenses increased 60.2% to $6.3 million, or 41.9% of total revenues, in the three months ended June 30, 1999 from $3.9 million, or 46.1% of total revenues, in the three months ended June 30, 1998. Sales and marketing expenses increased 59.9% to $11.9 million, or 41.6% of total revenues, in the six months ended June 30, 1999 from $7.4 million, or 47.7% of total revenues, in the six months ended June 30, 1998. The increase in absolute dollars was primarily the result of increased headcount to continue to build the direct sales force along with additional marketing and promotional activities to penetrate the market. The decline in sales and marketing expenses as a percentage of total revenues is due to sales productivity improvements resulting from the expansion of the Network Health product family, increased revenues from existing customers, improved lead generation and reduced sales cycles. Headcount in sales and marketing increased from 53 to 98 people from June 30, 1998 to June 30, 1999. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of salaries for financial, administrative and management personnel and related travel expenses, as well as legal and accounting expenses. General and administrative expenses increased 34.0% to $796,000, or 5.3% of total revenues, in the three months ended June 30, 1999 from $594,000, or 7.0% of total revenues, in the three months ended June 30, 1998. General and administrative expenses increased 36.9% to $1.6 million, or 5.6% of total revenues, in the six months ended June 30, 1999 from $1.2 million, or 7.5% of total revenues, in the six months ended June 30, 1998. The increase in absolute dollars is associated with an increase of costs in general support areas. Headcount in general and administrative functions increased from 13 to 16 people from June 30, 1998 to June 30, 1999. General and administrative expenses declined as a percentage of total revenues during the 1999 period due to a significant increase in revenues during that period. OTHER INCOME. Other income consists of interest earned on funds available for investment. The Company had net other income of $751,000 for the three months ended June 30, 1999 and net other income of $556,000 for the three months ended June 30, 1998. The Company had net other income of $1.5 million for the six months ended June 30, 1999 and net other income of $1.1 million for the six months ended June 30, 1998. The increase in net other income is attributed to the investment of proceeds from the Company's IPO. LIQUIDITY AND CAPITAL RESOURCES The Company financed its operations, prior to its initial public offering, primarily through the private sale of equity securities and a credit line for equipment purchases. On October 24, 1997, the Company completed its initial public offering of 3,335,000 shares of Common Stock at a price of $14.00 per share. Of these shares, 2,735,000 were issued by the Company and 600,000 were sold by selling shareholders. The Company received net proceeds of approximately $34.7 million. The Company had working capital of $48.0 million at June 30, 1999. Net cash provided by operating activities was $7.1 million and $4.3 million for the three months ended June 30, 1999 and 1998, respectively. Cash, cash equivalents and marketable securities were $59.0 million and $40.5 million at June 30, 1999 and 1998, respectively. Deferred revenues increased for the six months ended June 30, 1999 by $1.2 million due to an increase in overall sales activity; the increase consisted of $1.6 million from deferred maintenance contracts and a decrease of $399,000 from service and software license sales with remaining contingencies such as completion of services, product acceptance and credit worthiness. Investing activities have consisted of the acquisition of property and equipment, most notably computer and networking equipment to support the growing employee base and corporate infrastructure and also investments in marketable securities. The Company manages its market risk on its investment securities by selecting investment grade securities with the highest credit ratings of relatively short duration that trade in highly liquid markets. Financing activities consisted primarily of the issuance of common stock and exercise of options during the three months ended June 30, 1999 and 1998. 10 11 Pursuant to the Tax Reform Act of 1986, the utilization of net operating loss carryforwards for tax purposes may be subject to an annual limitation if a cumulative change of ownership of more than 50% occurs over a three-year period. As a result of the Company's 1995 preferred stock financings, such a change in ownership has occurred. As a result of this ownership change, the use of the net operating loss carryforwards is limited. The Company has determined that its initial public offering did not cause another ownership change. The Company has deferred tax assets of approximately $17.3 million composed primarily of net operating loss carryforwards and research and development credits. The Company has fully reserved for these deferred tax assets by recording a valuation allowance of $17.3 million, as the Company believes that it is more likely than not that it will not be able to realize this asset. Pursuant to paragraphs 20 to 25 of Statement of Financial Accounting Standards (SFAS) No. 109, the Company considered both positive and negative evidence in assessing the need for a valuation allowance at December 31, 1997 and 1998. The factors that weighed most heavily on the Company's decision to record a full valuation allowance were (i) the Company's history of losses, (ii) the substantial restrictions on the use of its existing net operation loss (NOL) carryforwards and (iii) the uncertainty of future profitability. As a result of the ownership change described above, the future use of approximately $16.6 million of the Company's NOL carryforwards are limited to only $330,000 per year; the substantial majority of such NOL carryforwards will expire before they can be used. Pursuant to the provisions of SFAS No. 109, the Company used all of its remaining unrestricted NOL and credit carryforwards in computing the 1998 tax provision. The Company is also subject to rapid technology change, competition from substantially larger competitors, a limited family of products and other related risks, as more thoroughly described in the "Risk Factors" section of the Company's Form 10-K, for the fiscal year ended December 31, 1998. The Company's dependence on a single product family in an emerging market makes the prediction of future results difficult, if not impossible, especially in the highly competitive software industry. As a result, the Company found the evidence described above to be the most reliable objective evidence available in determining that a full valuation allowance against its tax assets would be necessary. The Company's net operating loss deferred tax asset includes approximately $6.5 million pertaining to the benefit associated with the exercise and subsequent disqualifying disposition of incentive stock options by the Company's employees. When and if the Company realizes this asset, the resulting change in the valuation allowance will be credited directly to additional paid-in capital, pursuant to the provisions of SFAS No. 109. The Company received a tax benefit of approximately $3.0 million pursuant to the exercise of employee stock options. The Company recorded this benefit as a component of additional paid in capital for the period ended June 30, 1999. The Company's current export sales are denominated in United States dollars. To the extent that international sales continue to be denominated in United States dollars, an increase in the value of the United States dollar relative to other currencies could make the Company's products and services more expensive and, therefore, potentially less competitive in international markets. As of March 31, 1999, the Company's principal sources of liquidity included cash and marketable securities. The Company believes that its current cash and market securities and cash provided by future operations will be sufficient to meet its working capital and anticipated capital expenditure requirements for the next 12 months. Although operating activities may provide cash in certain periods, to the extent the Company experiences growth in the future, its operating and investing activities may require significant cash. Consequently, any such future growth may require the Company to obtain additional equity or debt financing. YEAR 2000 COMPLIANCE / YEAR 2000 READINESS DISCLOSURE STATEMENT The company is aware of the issues associated with the programming code in existing computer systems and software products as the millennium (Year 2000) approaches. The Company has set up a task force which consists of the Director of Information Technology (IT) and Operations, the Manager of System Applications and representative personnel from each functional area. This task force is addressing the Year 2000 issue in the following categories: the Network Health product; internal business computer systems and software applications; internal systems other than computer hardware and software; and systems of the Company's external suppliers and service providers. The Company is also assessing its Year 2000 associated costs, risks and potential contingency plans. Despite the Company's efforts with respect to the Year 2000 issue, there can be no assurance that the Company's business, results of operations or financial condition would not be materially adversely affected by the failure of the Company's products, its internal systems and applications or the systems of its third party suppliers and service providers to properly operate or manage data beyond 1999. 11 12 NETWORK HEALTH PRODUCT. In 1997, the Company initiated the necessary development to ensure Year 2000 compliance in the Network Health family of applications and believes it has achieved Year 2000 compliance in Network Health 4.1 which was released in August 1998. The Company's existing customers can receive this release and future releases, at no charge, through their annual software maintenance contract. The Company requires its customers to purchase software maintenance in order to receive product support. Specifically, the Company defines Year 2000 Compliance as the following: no value for current date will cause any interruption in operation; date-based functionality must behave consistently for dates prior to, during, and after Year 2000; in all interfaces and data storage, the century in any date must be specified either explicitly or by unambiguous algorithms or inferencing rules; Year 2000 must be recognized as a leap year. The Company's definition of Year 2000 Compliance is adopted from the British Standard Institute's Definition of Year 2000 Conformity Requirements (PD2000-1). A copy of the standard is available for review on the Company's website. The Company makes no guarantee of, claims no responsibility for and disclaims any liability to its customers, with respect to Year 2000 compliance of operating platforms, hardware, software or other products not developed by the Company, including equipment monitored by the Network Health product. INTERNAL BUSINESS COMPUTER SYSTEMS AND SOFTWARE APPLICATIONS. In 1998, the Company commenced a Year 2000 date conversion project to address all internal existing computer systems, software applications and related computer equipment (e.g. printers) used in conjunction with its internal operations. The Company plans to identify, modify, upgrade and/or replace any systems that have been identified as non-Year 2000 compliant to minimize the possibility of a material disruption to it business. The Company has finished assessing all existing internal systems and expects to complete the compliance process on these systems before the end of 1999. INTERNAL SYSTEMS OTHER THAN COMPUTER HARDWARE AND SOFTWARE. The operation of office and facilities equipment such as fax machines, photocopiers, telephone switches, security systems, elevators, and other common devices may also be affected by the Year 2000 issue. The Company has identified and assessed its options to remediate, the Year 2000 issue on its office and facilities equipment. The Company expects to complete any needed modifications and upgrades on its office and facilities equipment before the end of 1999. SYSTEMS OF EXTERNAL SUPPLIERS AND SERVICE PROVIDERS. The Company has initiated communications with third party suppliers of the computers, software and other equipment used, operated or maintained by the Company to identify and, to the extent possible, to resolve any issues regarding the Year 2000 issue. The Company has also initiated communications with facilities service providers upon which the Company relies for daily operations. All external suppliers and service providers have been asked to provide a written assurance that they are also preparing to be Year 2000 compliant in a timely manner, and that their products/services will be available to the Company up to and beyond the Year 2000, without interruption. A response has been received from approximately 75% of these suppliers and service providers. However, there can be no assurance that the systems operated by other companies upon which the Company relies will be Year 2000 compliant on a timely basis. ASSOCIATED COSTS. To date, the Company has not incurred any material costs related to the assessment of, and efforts to upgrade or replace existing systems identified as non-Year 2000 compliant. Management is continuing to assess the total Year 2000 compliance expense, but based on a review to date, does not expect the amounts required to be expensed over the balance of 1999 to have an adverse material effect on its business, results of operations or financial condition. There can be no assurance, however, that further assessment of the Company's internal systems and applications will not indicate that additional Company efforts to assure Year 2000 compliance are necessary, and that such efforts may be costly. ASSOCIATED RISKS. The Company expects to identify and resolve all Year 2000 issues that could materially adversely affect its business, financial condition or results of operations. However, management realizes it may not be possible to determine with complete certainty that all Year 2000 problems affecting the Company will be identified or corrected in a timely manner. As a result, the Company could be at risk of experiencing a significant number of operational inconveniences and inefficiencies that may divert management's time and attention from its ordinary business activities and at risk of experiencing a lesser number of serious system or product failures that may require significant efforts by the Company to prevent or alleviate material business disruptions. CONTINGENCY PLANS. The Company recognizes the importance of readiness for potential worst case scenarios. As a result, the Company is working to identify scenarios with significant risks, which would require contingency plans. The Company has begun to develop and expects to complete any needed contingency plans no later than the fall of 1999. CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS 12 13 The Company does not provide forecasts of the future financial performance of the Company. From time to time, however, the information provided by the Company or statements made by its employees may contain forward looking statements. This document contains forward looking statements. Any statements contained herein that do not describe historical facts are forward looking statements. The Company makes such forward looking statements under the provisions of the "safe harbor" section of the Private Securities Litigation Reform Act of 1995. The forward looking statements contained herein are based on current expectations, but are subject to a number of risks and uncertainties. In particular, statements contained in Management's Discussion and Analysis of Financial Condition and Results of Operations which are not historical facts (including, but not limited to, statements concerning the plans and objectives of management; increases in sales and marketing, research and development and general and administrative expenses; expenses associated with Year 2000 and the Company's expected liquidity and capital resources) constitute forward-looking statements. The Company's actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below, and the other risks discussed in the Company's 1998 Annual Report on Form 10-K filed with the Securities and Exchange Commission in March 1999. LIMITED OPERATING HISTORY; UNCERTAINTY OF FUTURE OPERATING RESULTS The Company changed its focus to network management software in 1991 and commercially introduced its first Network Health product in 1995. Accordingly, the Company has only a limited operating history in the network performance analysis and reporting market upon which an evaluation of its business and prospects can be based. The Company has incurred significant net losses in each of the last five fiscal years preceding fiscal year 1997. As of June 31, 1999, the Company had accumulated net losses of $17.0 million. The limited operating history of the Company and its dependence on a single product family in an emerging market makes the prediction of future results of operations difficult or impossible, and the Company and its prospects must be considered in light of the risks, costs and difficulties frequently encountered by emerging companies, particularly companies in the competitive software industry. Although the Company has achieved recent revenue growth, and profitability for the fiscal years ended 1998 and 1997, there can be no assurance that the Company can generate substantial additional revenue growth on a quarterly or annual basis, or that any revenue growth that is achieved can be sustained. Revenue growth that the Company has achieved or may achieve may not be indicative of future operating results. In addition, the Company has increased, and plans to increase further, its operating expenses in order to fund higher levels of research and development, increase its sales and marketing efforts, develop new distribution channels, broaden its customer support capabilities and expand its administrative resources in anticipation of future growth. To the extent that increases in such expenses precede or are not subsequently followed by increased revenues, the Company's business, results of operations and financial condition would be materially adversely affected. There can be no assurance that the Company will sustain profitability on a quarterly or annual basis. The Company must achieve substantial revenue growth in order to sustain profitability. In addition, in view of recent revenue growth, the rapidly evolving nature of its business and markets and its limited operating history in its current market, the Company believes that period-to-period comparisons of financial results are not necessarily meaningful and should not be relied upon as an indication of future performance. In light of the Company's strong performance to date in 1999, the Company recorded a tax provision of $3.2 million in the six months ended June 30, 1999. POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS The Company is likely to experience significant fluctuations in quarterly operating results caused by many factors, including, but not limited to: (i) changes in the demand for the Company's products; (ii) the timing, composition and size of orders from the Company's customers, including the tendency for significant bookings to occur in the last month of each fiscal quarter; (iii) spending patterns and budgetary resources of its customers on network management software solutions; (iv) the success of the Company's new customer generation activities; (v) introductions or enhancements of products, or delays in the introductions or enhancements of products, by the Company or its competitors; (vi) changes in the Company's pricing policies or those of its competitors; (vii) changes in the distribution channels through which products are sold; (viii) the Company's ability to anticipate and effectively adapt to developing markets and rapidly changing technologies; (ix) changes in networking or communications technologies; (x) the Company's ability to attract, retain and motivate qualified personnel; (xi) changes in the mix of products sold; (xii) the publication of opinions about the Company and its products, or its competitors and their products, by industry analysts or others; and (xiii) changes in general economic conditions. Unlike other software companies with a longer history of operations, the Company does not derive a significant portion of its revenues from maintenance contracts, and therefore does not have a significant ongoing revenue stream that may tend to mitigate quarterly fluctuations in operating results. Furthermore, the Company is attempting to expand its channels of distribution, and increases in the Company's revenues will be dependent on its ability to implement successfully its distribution strategy. Due to the buying patterns of certain of the Company's customers and also to the Company's own sales incentive programs focused on annual sales goals, revenues in the Company's fourth quarter could be higher than revenues in the first quarter of the succeeding year. There also may be other factors that significantly affect the Company's quarterly results which are difficult to predict 13 14 given the Company's limited operating history, such as seasonality and the timing of receipt and delivery of orders within a fiscal quarter. Consistent with software industry practice, the Company expects to operate with a limited amount of backlog. As a result, quarterly sales and operating results depend generally on the volume and timing of orders within the quarter, the tendency of sales to occur late in fiscal quarters and the ability of the Company to fill orders received within the quarter, all of which are difficult to forecast and manage. The Company's expense levels are based in part on its expectations of future orders and sales, which, given the Company's limited operating history, are extremely difficult to predict. A substantial portion of the Company's operating expenses are related to personnel, facilities, and sales and marketing programs. This level of spending for such expenses cannot be adjusted quickly and is, therefore, relatively fixed in the short term. Accordingly, any significant shortfall in demand for the Company's products in relation to the Company's expectations would have an immediate and material adverse effect on the Company's business, results of operations and financial condition. Due to all of the foregoing factors, the Company believes that its quarterly operating results are likely to vary significantly in the future. Therefore, in some future quarter the Company's results of operations may fall below the expectations of securities analysts and investors. In such event, the trading price of the Company's Common Stock would likely be materially adversely affected. EMERGING NETWORK MANAGEMENT SOFTWARE MARKET The market for the Company's products is in an early stage of development. Although the rapid expansion and increasing complexity of computer networks in recent years has increased the demand for network management software products, the awareness of and the need for such products is a recent development. Because the market for these products is only beginning to develop, it is difficult to assess the size of this market, the appropriate features and prices for products to address this market, the optimal distribution strategy and the competitive environment that will develop. The development of this market and the Company's growth will be significantly dependent on the willingness of network service providers, including telecommunications carriers, internet service providers, systems integrators and outsourcers, to integrate network performance analysis and reporting software into their product and service offerings. Failure of the network performance analysis and reporting market to grow or failure of the Company to properly assess and address such market would have a material adverse effect on the Company's business, results of operations and financial condition. DEPENDENCE ON TELECOMMUNICATIONS CARRIERS A significant portion of the Company's revenues are, and are expected to continue to be, attributable to sales of products to telecommunications carriers. The Company's future performance is significantly dependent upon telecommunications carriers' increased incorporation of the Company's solutions as part of their package of product and service offerings to end users. The failure of the Company's products to perform favorably in and become an accepted component of the telecommunications carriers' product and service offerings, or a slower than expected increase or a decrease in the volume of sales of the Company's products and services to telecommunications carriers, could have a material adverse effect on the Company's business, results of operations and financial condition. CONCENTRATED PRODUCT FAMILY The Company currently derives substantially all of its revenues from its Network Health product family, and the Company expects that revenues from these products will continue to account for substantially all of the Company's revenues for the foreseeable future. Broad market acceptance of these products is, therefore, critical to the Company's future success, and any factor adversely affecting sales or pricing levels of these products could have a material adverse effect on the Company's business, results of operations and financial condition. There can be no assurance that market acceptance of Network Health will increase or even remain at current levels. Factors that may affect the market acceptance of the Company's products include the availability and price of competing products and technologies and the success of the sales efforts of the Company and its marketing partners. Moreover, the Company anticipates that its competitors will introduce additional competitive products, particularly if demand for network management software products increases, which may reduce future market acceptance of the Company's products. In addition, new competitors could enter the Company's market and offer alternative products which may impact the market acceptance of the Company's products. The Company's future performance will also depend in part on the successful development, introduction and market acceptance of new and enhanced products. There can be no assurance that any such new or enhanced products will be successfully developed, introduced and marketed, and failure to do so would have a material adverse effect on the Company's business, results of operations and financial condition. 14 15 RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON STANDARD PROTOCOLS The software industry is characterized by rapid technological change, frequent introductions of new products, changes in customer demands and evolving industry standards. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. Network Health's ability to analyze and generate reports, as well as the quality of the reports, is dependent on Network Health's utilization of the industry-standard SNMP protocol and the data resident in conventional MIBs. Any change in these industry standards, the development of vendor-specific proprietary MIB technology, or the emergence of new network technologies could affect the compatibility of Network Health with these devices which, in turn, could affect Network Health's ability to analyze and generate comprehensive reports or the quality of the reports. Furthermore, although the Company's products currently run on industry-standard UNIX operating systems and Windows NT, any significant change in industry-standard operating systems could affect the demand for, or the pricing of, the Company's products. Any of the foregoing developments could have a material adverse effect on the Company's business, results of operations and financial condition. PRODUCT ENHANCEMENTS AND NEW PRODUCTS Because of rapid technological change in the software industry and potential changes in the network management software market and industry standards, the life cycle of versions of Network Health is difficult to estimate. The Company's future success will depend upon its ability to address the increasingly sophisticated needs of its customers by developing and introducing enhancements to Network Health on a timely basis that keep pace with technological developments, emerging industry standards and customer requirements. There can be no assurance that the Company will be successful in developing and marketing enhancements to Network Health or in developing new products that respond to technological changes, evolving industry standards or customer requirements, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and sale of such enhancements or new products, or that such enhancements or new products will adequately address the requirements of the marketplace and achieve any significant degree of market acceptance. COMPETITION; NEW ENTRANTS The market for the Company's products is new, intensely competitive, rapidly evolving and subject to technological change. Competitive and alternative offerings are available from the major product categories of remote monitoring (RMON) probe vendors, element management software, and other performance analysis and reporting offerings. Another area of competition comes from a number of companies offering network performance reporting services; including International Network Services (INS). In addition, the Company expects the large network management platform vendors to begin to offer products directly competitive with the Company's products. These companies may bundle their products with other hardware and software in a manner that may discourage users from purchasing products offered by the Company. This strategy may be particularly effective for companies with leading market shares in the network hardware and software market, including Hewlett-Packard Company, Lucent Technologies, International Business Machines Corporation and Cabletron Systems, Inc. Developers of network element management solutions such as Cisco Systems, Inc., 3Com Corporation and Nortel Networks, Inc. may also compete with the Company in the future. The Company expects competition to persist, increase and intensify in the future with possible price competition developing in the Company's markets. Many of the Company's current and potential competitors have longer operating histories and significantly greater financial, technical and marketing resources and name recognition than the Company. The Company does not believe its market will support a large number of competitors and their products. In the past, a number of software markets have become dominated by one or a small number of suppliers, and a small number of suppliers or even a single supplier may dominate the Company's market. If the Company does not provide products that achieve success in its market in the short term, the Company could suffer an insurmountable loss in market share and brand name acceptance, which would result in a material adverse effect on the Company's business, results of operations and financial condition. There can be no assurance that the Company will be able to compete effectively with current and future competitors. UNCERTAIN PROTECTION OF INTELLECTUAL PROPERTY RIGHTS The Company's success depends significantly upon its proprietary technology. The Company relies on a combination of patent, copyright, trademark and trade secret laws, non-disclosure agreements and other contractual provisions to establish, maintain and protect its proprietary rights, all of which afford only limited protection. The Company has four issued U.S. patents, three pending U.S. patent applications, and various foreign counterparts. There can be no assurance that patents will issue from these pending applications or from any future applications or that, if issued, any claims allowed will be sufficiently broad to protect the Company's technology. In addition, there can be no assurance that any patents that have been or may be issued will not be challenged, invalidated 15 16 or circumvented, or that any rights granted thereunder would provide protection of the Company's proprietary rights. Failure of any patents to protect the Company's technology may make it easier for the Company's competitors to offer equivalent or superior technology. The Company has registered or applied for registration for certain trademarks, and will continue to evaluate the registration of additional trademarks as appropriate. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or services or to obtain and use information that the Company regards as proprietary. Third parties may also independently develop similar technology without breach of the Company's proprietary rights. In addition, the laws of some foreign countries do not protect proprietary rights to as great an extent as do the laws of the United States. In addition, the Company's products are licensed under shrink wrap license agreements that are not signed by licensees and therefore may not be binding under the laws of certain jurisdictions. Certain technologies used by the Company's products are licensed from third parties, generally on a non-exclusive basis. The termination of any such licenses, or the failure of the third-party licensors to adequately maintain or update their products, could result in delay in the Company's ability to ship certain of its products while it seeks to implement technology offered by alternative sources, and any required replacement licenses could prove costly. While it may be necessary or desirable in the future to obtain other licenses relating to one or more of the Company's products or relating to current or future technologies, there can be no assurance that the Company will be able to do so on commercially reasonable terms or at all. Although the Company does not believe that it is infringing the intellectual property rights of others, claims of infringement are becoming increasingly common as the software industry develops and legal protections, including patents, are applied to software products. Litigation may be necessary to protect the Company's proprietary technology, and third parties may assert infringement claims against the Company with respect to their proprietary rights. Any claims or litigation can be time-consuming and expensive regardless of their merit. Infringement claims against the Company can cause product release delays, require the Company to redesign its products or require the Company to enter into royalty or license agreements, which agreements may not be available on terms acceptable to the Company or at all. RISK OF PRODUCT DEFECTS; PRODUCT LIABILITY As a result of their complexity, software products may contain undetected errors or failures when first introduced or as new versions are released. There can be no assurance that, despite testing by the Company and testing and use by current and potential customers, errors will not be found in new products after commencement of commercial shipments or, if discovered, that the Company will be able to successfully correct such errors in a timely manner or at all. The occurrence of errors and failures in the Company's products could result in loss of or delay in market acceptance of the Company's products, and alleviating such errors and failures could require significant expenditure of capital and other resources by the Company. The consequences of such errors and failures could have a material adverse effect on the Company's business, results of operations and financial condition. Since the Company's products are used by its customers to predict future network problems and avoid failures of the network to support critical business functions, design defects, software errors, misuse of the Company's products, incorrect data from network elements or other potential problems within or out of the Company's control that may arise from the use of the Company's products could result in financial or other damages to the Company's customers. The Company does not maintain product liability insurance. Although the Company's license agreements with its customers typically contain provisions designed to limit the Company's exposure to potential claims as well as any liabilities arising from such claims, such provisions may not effectively protect the Company against such claims and the liability and costs associated therewith. Accordingly, any such claim could have a material adverse effect upon the Company's business, results of operations and financial condition. The Company provides warranties for its products for a period of time (currently three months) after the software is purchased. The Company's license agreements generally do not permit product returns by the customer, and product returns and warranty expense for fiscal 1998, 1997 and 1996 represented less than 1.0% of total revenues during each of such periods. However, no assurance can be given that product returns will not increase as a percentage of total revenues in future periods. RELIANCE ON STRATEGIC PARTNERS AND OTHER EVOLVING DISTRIBUTION CHANNELS The Company's distribution strategy is to develop multiple distribution channels, including sales through strategic marketing partners and value added resellers, such as Newbridge Networks Corporation; telecommunications carriers, such as MCI Communications Corporation; OEMs, such as Cabletron Systems, Inc.; and independent software vendors, as well as international distributors (collectively "channel partners"). The Company has developed a number of these relationships and intends to continue to 16 17 develop new channel partner relationships. Accordingly, the success of the Company will be dependent in large part on its ability to develop these additional distribution relationships and on the performance and success of these third parties, particularly telecommunications carriers and other network service providers. The Company's channel partner relationships have been established recently, and the Company cannot predict the extent to which its channel partners will be successful in marketing the Company's products. The Company generally expects that its agreements with its channel partners will be terminable by either party without cause. None of the Company's channel partners are required to purchase minimum quantities of the Company's products and none of these agreements contain exclusive distribution arrangements. The Company's inability to attract important and effective channel partners, or their inability to penetrate their respective market segments, or the loss of any of the Company's channel partners, as a result of competitive products offered by other companies or products developed internally by these channel partners or otherwise, could materially adversely affect the Company's business, results of operations and financial condition. MANAGEMENT OF POTENTIAL GROWTH The Company recently has experienced significant growth in its sales and operations and in the complexity of its products and product distribution channels. The Company has recently increased and is continuing to increase the size of its sales force and coverage territories. Furthermore, the Company has recently established and is continuing to establish additional distribution channels through third party relationships. The Company's growth, coupled with the rapid evolution of the Company's markets, has placed, and is likely to continue to place, significant strains on its administrative, operational and financial resources and increase demands on its internal systems, procedures and controls. If the Company is unable to manage future growth effectively, the Company's business, results of operations and financial condition could be materially adversely affected. DEPENDENCE ON KEY PERSONNEL The Company's performance is substantially dependent on the performance of its key technical and senior management personnel, none of whom is bound by an employment agreement. The loss of the services of any of such personnel could have a material adverse effect on the business, results of operations and financial condition of the Company. The Company does not maintain key person life insurance policies on any of its employees. The Company's success is highly dependent on its continuing ability to identify, hire, train, motivate and retain highly qualified management, technical, and sales and marketing personnel, including recently hired officers and other employees. Competition for such personnel is intense, and there can be no assurance that the Company will be able to attract, assimilate or retain highly qualified technical and managerial personnel in the future. The inability to attract and retain the necessary management, technical, and sales and marketing personnel could have a material adverse effect on the Company's business, results of operations and financial condition. EXPANSION INTO INTERNATIONAL MARKETS The Company intends to expand its operations outside of the United States and enter additional international markets, primarily through the establishment of additional reseller arrangements. The Company expects to commit additional time and development resources to customizing its products and services for selected international markets and to developing international sales and support channels. There can be no assurance that such efforts will be successful. In addition to the uncertainty as to the Company's ability to establish an international presence, there are certain difficulties and risks inherent in doing business internationally, including, but not limited to: (i) costs of customizing products and services for international markets; (ii) dependence on independent resellers; (iii) multiple and conflicting regulations; (iv) exchange controls; (v) longer payment cycles; (vi) unexpected changes in regulatory requirements; (vii) import and export restrictions and tariffs; (viii) difficulties in staffing and managing international operations; (ix) greater difficulty or delay in accounts receivable collection; (x) potentially adverse tax consequences; (xi) the burden of complying with a variety of laws outside the United States; (xii) the impact of possible recessionary environments in economies outside the United States; and (xiii) political and economic instability. In addition, the Company's ability to expand its business in certain countries will require modification of its products, particularly national language support. The Company's current export sales are denominated in United States dollars and the Company currently expects to continue this practice as it expands its international operations. To the extent that international sales continue to be denominated in U.S. dollars, an increase in the value of the United States dollar relative to other currencies could make the Company's products and services more expensive and, therefore, potentially less competitive in international markets. To the extent that future international sales are denominated in foreign currency, the Company's operating results will be subject to risks associated with foreign currency fluctuation and the Company would consider entering into forward exchange contracts or otherwise engaging in hedging activities. To date, as all export sales are denominated in U.S. dollars, the Company has not entered into any such contracts or engaged in any such 17 18 activities. As the Company increases its international sales, its total revenue may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and other parts of the world. POSSIBLE VOLATILITY OF STOCK PRICE The Company completed an initial public offering of its common stock during October of 1997. The market price of the shares of Common Stock may be highly volatile and could be subject to wide fluctuations in response to variations in results of operations, announcements of technological innovations or new products by the Company or its competitors, changes in financial estimates by securities analysts or other events or factors. In addition, the financial markets have experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of many high technology companies and that often have been unrelated to the operating performance of such companies or have resulted from the failure of the operating results of such companies to meet market expectations in a particular quarter. Broad market fluctuations or any failure of the Company's operating results in a particular quarter to meet market expectations may adversely affect the market price of the shares of Common Stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against such a company. Such litigation could result in substantial costs and a diversion of management's attention and resources, which would have a material adverse effect on the Company's business, results of operations and financial condition. FUTURE CAPITAL FUNDING The Company plans to continue to expend substantial funds on the continued development, sales and marketing of the Network Health product family. There can be no assurance that the Company's existing capital resources, the proceeds from the Company's initial public offering during October of 1997 and any funds that may be generated from future operations together will be sufficient to finance the Company's future operations or that other sources of funding will be available on terms acceptable to the Company, if at all. In addition, future sales of substantial amounts of the Company's securities in the public market could adversely affect prevailing market prices and could impair the Company's future ability to raise capital through the sale of its securities. The failure to obtain such funding, if required, could have a material adverse effect on the Company's business, results of operations and financial condition. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments. The Company does not invest in derivative financial instruments, other financial instruments or derivative commodity instruments for which fair value disclosure would be required under SFAS No. 107. All of the Company's investments are in investment grade securities with high credit ratings of relatively short duration that trade in highly liquid markets and are carried at fair value on the Company's books. Accordingly, the Company has no quantitative information concerning the market risk of participating in such investments. Primary Market Risk Exposures. The Company's primary market risk exposure is in the area of interest rate risk. The Company's investment portfolio of cash equivalents is subject to interest rate fluctuations, but the Company believes this risk is immaterial due to the short-term nature of these investments. Substantially all of the Company's business outside the United States is conducted in U.S. dollar-denominated transactions, whereas the Company's operating expenses in its international branches are denominated in local currency. The Company has no foreign exchange contracts, option contracts or other foreign hedging arrangements. The Company believes that the operating expenses of its foreign operations are immaterial, and therefore any associated market risk is unlikely to have a material adverse effect on the Company's business, results of operations or financial condition. 18 19 CONCORD COMMUNICATIONS, INC. FORM 10-Q, JUNE 30, 1999 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is not a party to any litigation that it believes could have a material adverse effect on the business, results of operations and financial condition of the Company. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (d) Use of Proceeds On October 16, 1997, the Company commenced an initial public offering ("IPO") of 2,900,000 shares of common stock, par value $.01 per share (the "Common Stock"), of the Company pursuant to the Company's final prospectus dated October 15, 1997 (the "Prospectus"). The Prospectus was contained in the Company's Registration Statement on Form S-1, which was declared effective by the Securities and Exchange Commission (SEC File No. 333-33227) on October 15, 1997. Of the 2,900,000 shares of Common Stock offered, 2,300,000 shares were offered and sold by the Company and 600,000 shares were offered and sold by certain stockholders of the Company. As part of the IPO, the Company granted the several underwriters an overallotment option to purchase up to an additional 435,000 shares of Common Stock (the "Underwriters' Option"). The IPO closed on October 21, 1997 upon the sale of 2,900,000 shares of Common Stock to the underwriters. On October 24, 1997, the Representatives, on behalf of the several underwriters, exercised the Underwriters' Option, purchasing 435,000 additional shares of Common Stock from the Company. The aggregate offering price of the IPO to the public was $40,600,000 (exclusive of the Underwriters' Option), with proceeds to the Company and selling shareholders, after deduction of the underwriting discount, of $29,946,000 (before deducting offering expenses payable by the Company) and $7,812,000 respectively. The aggregate offering price of the Underwriters' Option exercised was $6,090,000, with proceeds to the Company, after deduction of the underwriting discount, of $5,663,700 (before deducting offering expenses payable by the Company). The aggregate amount of expenses incurred by the Company in connection with the issuance and distribution of the shares of Common Stock offered and sold in the IPO were approximately $3.6 million, including $2.7 million in underwriting discounts and commissions and $950,000 in other offering expenses. The net proceeds to the Company from the IPO, after deducting underwriting discounts and commissions and other offering expenses were approximately $34.7 million. To date, the Company has not utilized any of the net proceeds from the IPO. The Company has invested all such net proceeds primarily in US treasury obligations and other interest bearing investment grade securities. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its Annual Meeting of stockholders on April 27, 1999. At the Annual Meeting, the stockholders of the Company elected three Class II Directors, approved the Company's 1997 Stock Plan (as amended) and ratified the selection of the firm of Arthur Andersen LLP as auditors for the Company for the fiscal year ending December 31, 1999. The voting results were as follows: Total Vote For Total Vote Withheld -------------- ------------------- Election of Directors Frederick W.W. Bolander 11,331,582 20,291 Deepak Kamra 11,331,582 20,291 Robert M. Wadsworth 11,331,582 20,291 Broker For Against Abstain Non-Vote --- ------- ------- -------- Approval of 1997 Stock Plan, as amended 8,350,930 2,027,162 19,505 954,276 Ratification of Selection of Arthur Andersen LLP 11,273,774 65,600 12,499 0 ITEM 5. OTHER INFORMATION Not Applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The exhibits listed in the accompanying Exhibit Index on page 20 are filed or incorporated by reference as part of this Report. (b) Reports on Form 8-K None 19 20 CONCORD COMMUNICATIONS, INC. FORM 10-Q, JUNE 30, 1999 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Concord Communications, Inc. /s/ Gary E. Haroian --------------------------- Date: August 13, 1999 Name: Gary E. Haroian Title: Vice President of Finance and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) 20 21 CONCORD COMMUNICATIONS, INC. FORM 10-Q, JUNE 30, 1999 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.01 1997 Stock Plan of the Company, as amended on March 01, 1999 27.01 Financial Data Schedule 21 EX-10.1 2 1997 STOCK PLAN OF THE COMPANY 1 EXHIBIT 10.1 CONCORD COMMUNICATIONS, INC. 1997 STOCK PLAN (AS AMENDED ON MARCH 12, 1998 AND MARCH 1, 1999) 1. PURPOSE; TERMINATION OF PRIOR PLAN. The purpose of the 1997 Stock Plan (the "Plan") is to encourage key employees of Concord Communications, Inc. (the "Company") and of any present or future parent or subsidiary of the Company (collectively, "Related Corporations") and other individuals who render services to the Company or a Related Corporation, by providing opportunities to participate in the ownership of the Company and its future growth through (a) the grant of options which qualify as "incentive stock options" ("ISOs") under Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code"); (b) the grant of options which do not qualify as ISOs ("Non-Qualified Options"); (c) awards of stock in the Company ("Awards"); and (d) opportunities to make direct purchases of stock in the Company ("Purchases"). Both ISOs and Non-Qualified Options are referred to hereafter individually as an "Option" and collectively as "Options." Options, Awards and authorizations to make Purchases are referred to hereafter collectively as "Stock Rights." As used herein, the terms "parent" and "subsidiary" mean "parent corporation" and "subsidiary corporation," respectively, as those terms are defined in Section 424 of the Code. The Company's 1995 Stock Plan (the "1995 Stock Plan") is terminated effective as of October 16, 1997 and henceforth, the Company shall make no grants under the 1995 Stock Plan. The 1995 Stock Plan shall, however, continue to govern all options, awards and other grants granted and outstanding under the 1995 Stock Plan. 2. ADMINISTRATION OF THE PLAN. A. BOARD OR COMMITTEE ADMINISTRATION. The Plan shall be administered by the Board of Directors of the Company (the "Board") or, subject to paragraph 2(D) (relating to compliance with Section 162(m) of the Code), by a committee appointed by the Board of two or more of its members (the "Committee"). Hereinafter, all references in this Plan to the "Committee" shall mean the Board if no Committee has been appointed. Subject to ratification of the grant or authorization of each Stock Right by the Board (if so required by applicable state law), and subject to the terms of the Plan, the Committee shall have the authority to (i) determine to whom (from among the class of employees eligible under paragraph 3 to receive ISOs) ISOs shall be granted, and to whom (from among the class of individuals and entities eligible under paragraph 3 to receive Non-Qualified Options and Awards and to make Purchases) Non-Qualified Options, Awards and authorizations to make Purchases may be granted; (ii) determine the time or times at which Options or Awards shall be granted or Purchases made; (iii) determine the purchase price of shares subject to each Option or Purchase, which prices shall not be less than the minimum price specified in paragraph 6; (iv) determine whether each Option granted shall be an ISO or a Non-Qualified Option; (v) determine (subject to paragraph 7) the time or times when each Option shall become exercisable and the duration of the exercise period; (vi) determine whether restrictions such as repurchase options are to be imposed on shares subject to Options, Awards and Purchases and the nature of such restrictions, if any; and (vii) interpret the Plan and prescribe and rescind rules and regulations relating to it. If the Committee determines to issue a Non-Qualified Option, it shall take whatever actions it deems necessary, under Section 422 of the Code and the regulations promulgated thereunder, to ensure that such Option is not treated as an ISO. The interpretation and construction by the Committee of any provisions of the Plan or of any Stock Right granted under it shall be final unless otherwise determined by the Board. The Committee may from time to time adopt such rules and regulations for carrying out the Plan as it may deem best. No member of the Board or of the 1 2 Committee shall be liable for any action or determination made in good faith with respect to the Plan or any Stock Right granted under it. B. COMMITTEE ACTIONS. The Committee may select one of its members as its chairman, and shall hold meetings at such time and places as it may determine. A majority of the Committee shall constitute a quorum and acts of a majority of the members of the Committee at a meeting at which a quorum is present, or acts reduced to or approved in writing by all the members of the Committee (if consistent with applicable state law), shall be the valid acts of the Committee. From time to time the Board may increase the size of the Committee and appoint additional members thereof, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies however caused, or remove all members of the Committee and thereafter directly administer the Plan. C. GRANT OF STOCK RIGHTS TO BOARD MEMBERS. Notwithstanding the provisions of paragraph 2.A., no Stock Rights shall be granted to any person who is, at the time of the proposed grant, a member of the Board unless such grant is approved by a majority vote of the disinterested members of the Board. All grants of Stock Rights to members of the Board shall in all respects be made in accordance with the provisions of this Plan applicable to other eligible persons. Members of the Board who either (i) are eligible to receive grants of Stock Rights pursuant to the Plan or (ii) have been granted Stock Rights may vote on any matters affecting the administration of the Plan or the grant of any Stock Rights pursuant to the Plan, except that no such member shall act upon the granting to himself or herself of Stock Rights, but any such member may be counted in determining the existence of a quorum at any meeting of the Board during which action is taken with respect to the granting to such member of Stock Rights. Notwithstanding any other provision of this paragraph 2, in the event the Company registers any class of any equity security pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), any grants to members of the Board of Options made at any time from the effective date of such registration until six months after the termination of such registration shall be made only by the Board; provided, however, that if a majority of the Board is eligible to participate in the Plan or in any other stock option or other stock plan of the Company or any of its affiliates, or has been so eligible at any time within the preceding year, any grant to directors of Options must be made by, or only in accordance with the recommendation of, a Committee consisting of three or more persons, who may but need not be members of the Board or employees of the Company, appointed by the Board but having full authority to act in the matter, none of whom is eligible to participate in this Plan or any other stock option or other stock plan of the Company or any of its affiliates, or has been eligible at any time within the preceding year. The requirements imposed by the preceding sentence shall also apply with respect to grants to officers who are not also members of the Board. Once appointed, the Committee shall continue to serve until otherwise directed by the Board. D. PERFORMANCE-BASED COMPENSATION. The Board, in its discretion, may take such action as may be necessary to ensure that Stock Rights granted under the Plan qualify as "qualified performance-based compensation" within the meaning of Section 162(m) of the Code and applicable regulations promulgated thereunder ("Performance-Based Compensation"). Such action may include, in the Board's discretion, some or all of the following (i) if the Board determines that Stock Rights granted under the Plan generally shall constitute Performance-Based Compensation, the Plan shall be administered, to the extent required for such Stock Rights to constitute Performance-Based Compensation, by a Committee consisting solely of two or more "outside directors" (as defined in applicable regulations promulgated under Section 162(m) of the Code), (ii) if any Non-Qualified Options with an exercise price less than the fair market value per share of Common Stock are granted under the Plan and the Board determines that such Options should constitute Performance-Based Compensation, such options shall be made exercisable only upon the attainment of a pre-established, objective performance goal established by the 2 3 Committee, and such grant shall be submitted for, and shall be contingent upon shareholder approval and (iii) Stock Rights granted under the Plan may be subject to such other terms and conditions as are necessary for compensation recognized in connection with the exercise or disposition of such Stock Right or the disposition of Common Stock acquired pursuant to such Stock Right, to constitute Performance-Based Compensation. 3. ELIGIBLE EMPLOYEES AND OTHERS. ISOs may be granted only to employees of the Company or any Related Corporation. Non-Qualified Options, Awards and authorizations to make Purchases may be granted to any employee, officer or director (whether or not also an employee) or consultant of the Company or any Related Corporation. The Committee may take into consideration a recipient's individual circumstances in determining whether to grant a Stock Right. The granting of any Stock Right to any individual or entity shall neither entitle that individual or entity to, nor disqualify such individual or entity from, participation in any other grant of Stock Rights. 4. STOCK. The stock subject to Stock Rights shall be authorized but unissued shares of Common Stock of the Company, par value $.01 per share (the "Common Stock"), or shares of Common Stock reacquired by the Company in any manner. The aggregate number of shares which may be issued pursuant to the Plan is 2,500,000, subject to adjustment as provided in paragraph 13. If any Option granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part or shall be repurchased by the Company, the unpurchased shares of Common Stock subject to such Option shall again be available for grants of Stock Rights under the Plan. No employee of the Company or any Related Corporation may be granted Options to acquire, in the aggregate, more than 70% of the aggregate number of shares of Common Stock which may be issued pursuant to the Plan during any fiscal year of the Company. If any Option granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part or shall be repurchased by the Company, the shares subject to such Option shall be included in the determination of the aggregate number of shares of Common Stock deemed to have been granted to such employee under the Plan. 5. GRANTING OF STOCK RIGHTS. Stock Rights may be granted under the Plan at any time on or after October 16, 1997 and prior to October 15, 2007. The date of grant of a Stock Right under the Plan will be the date specified by the Committee at the time it grants the Stock Right; provided, however, that such date shall not be prior to the date on which the Committee acts to approve the grant. 6. MINIMUM OPTION PRICE; ISO LIMITATIONS. A. PRICE FOR NON-QUALIFIED OPTIONS, AWARDS AND PURCHASES. Subject to paragraph 2(D) (relating to compliance with Section 162(m) of the Code), the exercise price per share specified in the agreement relating to each Non-Qualified Option granted, and the purchase price per share of stock granted in any Award or authorized as a Purchase, under the Plan may be less than the fair market value of the Common Stock of the Company on the date of grant; provided that, in no event shall such exercise price or such purchase price be less than the lesser of (i) the book value per share of Common Stock as of the end of the fiscal year of the Company immediately preceding the date of such grant, or (ii) 50 percent of the fair market value per share of Common Stock on the date of such grant. B. PRICE FOR ISOS. The exercise price per share specified in the agreement relating to each ISO granted under the Plan shall not be less than the fair market value per share of Common Stock on the date of such grant. In the case of an ISO to be granted to an employee owning stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Related Corporation, the price per share specified in the agreement relating to such ISO shall not be less 3 4 than one hundred ten percent (110%) of the fair market value per share of Common Stock on the date of grant. For purposes of determining stock ownership under this paragraph, the rules of Section 424(d) of the Code shall apply. C. $100,000 ANNUAL LIMITATION ON ISO VESTING. Each eligible employee may be granted Options treated as ISOs only to the extent that, in the aggregate under this Plan and all incentive stock option plans of the Company and any Related Corporation, ISOs do not become exercisable for the first time by such employee during any calendar year with respect to stock having a fair market value (determined at the time the ISOs were granted) in excess of $100,000. The Company intends to designate any Options granted in excess of such limitation as Non-Qualified Options, and the Company shall issue separate certificates to the optionee with respect to Options that are Non-Qualified Options and Options that are ISOs. D. DETERMINATION OF FAIR MARKET VALUE. If, at the time an Option is granted under the Plan, the Company's Common Stock is publicly traded, "fair market value" shall be determined as of the date of grant or, if the prices or quotes discussed in this sentence are unavailable for such date, the last business day for which such prices or quotes are available prior to the date of grant and shall mean (i) the average (on that date) of the high and low prices of the Common Stock on the principal national securities exchange on which the Common Stock is traded, if the Common Stock is then traded on a national securities exchange; or (ii) the last reported sale price (on that date) of the Common Stock on the Nasdaq National Market, if the Common Stock is not then traded on a national securities exchange; or (iii) the closing bid price (or average of bid prices) last quoted (on that date) by an established quotation service for over-the-counter securities, if the Common Stock is not reported on the Nasdaq National Market. If the Common Stock is not publicly traded at the time an Option is granted under the Plan, "fair market value" shall mean the fair value of the Common Stock as determined by the Committee after taking into consideration all factors which it deems appropriate, including, without limitation, recent sale and offer prices of the Common Stock in private transactions negotiated at arm's length. 7. OPTION DURATION. Subject to earlier termination as provided in paragraphs 9 and 10 or in the agreement relating to such Option, each Option shall expire on the date specified by the Committee, but not more than (i) ten years from the date of grant in the case of Options generally and (ii) five years from the date of grant in the case of ISOs granted to an employee owning stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Related Corporation, as determined under paragraph 6(B). Subject to earlier termination as provided in paragraphs 9 and 10, the term of each ISO shall be the term set forth in the original instrument granting such ISO, except with respect to any part of such ISO that is converted into a Non-Qualified Option pursuant to paragraph 16. 8. EXERCISE OF OPTION. Subject to the provisions of paragraphs 9 through 12, each Option granted under the Plan shall be exercisable as follows: A. VESTING. The Option shall either be fully exercisable on the date of grant or shall become exercisable thereafter in such installments as the Committee may specify. B. FULL VESTING OF INSTALLMENTS. Once an installment becomes exercisable, it shall remain exercisable until expiration or termination of the Option, unless otherwise specified by the Committee. C. PARTIAL EXERCISE. Each Option or installment may be exercised at any time or from time to time, in whole or in part, for up to the total number of shares with respect to which it is then exercisable. D. ACCELERATION OF VESTING. The Committee shall have the right to accelerate the date that any installment of any Option becomes exercisable; provided that the Committee shall not, without the consent of an optionee, accelerate the permitted exercise date of any installment of any Option granted to 4 5 any employee as an ISO (and not previously converted into a Non-Qualified Option pursuant to paragraph 16) if such acceleration would violate the annual vesting limitation contained in Section 422(d) of the Code, as described in paragraph 6(C). 9. TERMINATION OF EMPLOYMENT. Unless otherwise specified in the agreement relating to such ISO, if an ISO optionee ceases to be employed by the Company and all Related Corporations other than by reason of death or disability as defined in paragraph 10, no further installments of his or her ISOs shall become exercisable, and his or her ISOs shall terminate after the passage of 60 days from the date of termination of his or her employment, but in no event later than on the specified expiration dates of such ISOs, except to the extent that such ISOs (or unexercised installments thereof) have been converted into Non-Qualified Options pursuant to paragraph 16. For purposes of this paragraph 9, a leave of absence with the written approval of the Committee shall not be considered an interruption of employment under the Plan, provided that such written approval contractually obligates the Company or any Related Corporation to continue the employment of the employee after the approved period of absence. Employment shall also be considered as continuing uninterrupted during any other bona fide leave of absence (such as those attributable to illness, military obligations or governmental service) provided that the period of such leave does not exceed 90 days or, if longer, any period during which such optionee's right to reemployment is guaranteed by statute or by contract. A bona fide leave of absence with the written approval of the Committee shall not be considered an interruption of employment under this paragraph 9, provided that such written approval contractually obligates the Company or any Related Corporation to continue the employment of the optionee after the approved period of absence. ISOs granted under the Plan shall not be affected by any change of employment within or among the Company and Related Corporations, so long as the optionee continues to be an employee of the Company or any Related Corporation. Nothing in the Plan shall be deemed to give any grantee of any Stock Right the right to be retained in employment or other service by the Company or any Related Corporation for any period of time. 10. DEATH; DISABILITY. A. DEATH. If an ISO optionee ceases to be employed by the Company and all Related Corporations by reason of his or her death, any ISO owned by such optionee may be exercised, to the extent otherwise exercisable on the date of death, by the estate, personal representative or beneficiary who has acquired the ISO by will or by the laws of descent and distribution, at any time prior to the earlier of (i) the specified expiration date of the ISO or (ii) 180 days from the date of the optionee's death. B. DISABILITY. If an ISO optionee ceases to be employed by the Company and all Related Corporations by reason of his or her disability, such optionee shall have the right to exercise any ISO held by him or her on the date of termination of employment, for the number of shares for which he or she could have exercised it on that date, at any time prior to the earlier of (i) the specified expiration date of the ISO or (ii) 180 days from the date of the termination of the optionee's employment. For the purposes of the Plan, the term "disability" shall mean "permanent and total disability" as defined in Section 22(e)(3) of the Code or any successor statute. 11. ASSIGNABILITY. No ISO shall be assignable or transferable by the optionee except by will or by the laws of descent and distribution, and during the lifetime of the optionee shall be exercisable only by such optionee. Stock Rights other than ISOs shall be transferable to the extent set forth in the agreement relating to such Stock Right. 12. TERMS AND CONDITIONS OF OPTIONS. Options shall be evidenced by instruments (which need not be identical) in such forms as the Committee may from time to time approve. Such instruments shall conform to the terms and conditions set forth in paragraphs 6 through 11 hereof and may contain such other provisions as the Committee deems advisable which are not inconsistent with the Plan, including restrictions applicable to 5 6 shares of Common Stock issuable upon exercise of Options. The Committee may specify that any Non-Qualified Option shall be subject to the restrictions set forth herein with respect to ISOs, or to such other termination and cancellation provisions as the Committee may determine. The Committee may from time to time confer authority and responsibility on one or more of its own members and/or one or more officers of the Company to execute and deliver such instruments. The proper officers of the Company are authorized and directed to take any and all action necessary or advisable from time to time to carry out the terms of such instruments. 13. ADJUSTMENTS. Upon the occurrence of any of the following events, an optionee's rights with respect to Options granted to such optionee hereunder shall be adjusted as hereinafter provided, unless otherwise specifically provided in the written agreement between the optionee and the Company relating to such Option: A. STOCK DIVIDENDS AND STOCK SPLITS. If the shares of Common Stock shall be subdivided or combined into a greater or smaller number of shares or if the Company shall issue any shares of Common Stock as a stock dividend on its outstanding Common Stock, the number of shares of Common Stock deliverable upon the exercise of Options shall be appropriately increased or decreased proportionately, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, combination or stock dividend. B. CONSOLIDATIONS OR MERGERS. If the Company is to be consolidated with or acquired by another entity in a merger or other reorganization in which the holders of the outstanding voting stock of the Company immediately preceding the consummation of such event, shall, immediately following such event, hold, as a group, less than a majority of the voting securities of the surviving or successor entity, or in the event of a sale of all or substantially all of the Company's assets or otherwise (each, an "Acquisition"), the Committee may take one or more of the following actions: (i) provide for the acceleration and/or termination of any time period relating to the exercise of the Options, (ii) provide for the purchase of the Options, upon the optionee's request, for the amount in cash that could have been received upon the exercise of the Options and sale of the shares obtained thereby, (iii) adjust the terms of the Options in a manner determined by the Committee, (iv) cause the Options to be assumed, or new rights substituted therefor, by another entity or (v) make such other provision as the Committee may consider equitable and in the best interests of the Company. C. RECAPITALIZATION OR REORGANIZATION. In the event of a recapitalization or reorganization of the Company (other than a transaction described in subparagraph B above) pursuant to which securities of the Company or of another corporation are issued with respect to the outstanding shares of Common Stock, an optionee upon exercising an Option shall be entitled to receive for the purchase price paid upon such exercise the securities he or she would have received if he or she had exercised such Option prior to such recapitalization or reorganization. D. MODIFICATION OF ISOS. Notwithstanding the foregoing, any adjustments made pursuant to subparagraphs A, B or C with respect to ISOs shall be made only after the Committee, after consulting with counsel for the Company, determines whether such adjustments would constitute a "modification" of such ISOs (as that term is defined in Section 424 of the Code) or would cause any adverse tax consequences for the holders of such ISOs. If the Committee determines that such adjustments made with respect to ISOs would constitute a modification of such ISOs or would cause adverse tax consequences to the holders, it may refrain from making such adjustments. E. RESTRICTED SECURITIES. If any person or entity owning restricted Common Stock obtained by exercise of an Option made hereunder receives new or additional or different shares or securities ("New Securities") in connection with a transaction described in subparagraphs A, B or C above, as a result of owning such restricted Common Stock, such New Securities shall be subject to all of the conditions and 6 7 restrictions applicable to the restricted Common Stock with respect to which such New Securities were issued. F. ISSUANCES OF SECURITIES. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares subject to Options. No adjustments shall be made for dividends paid in cash or in property other than securities of the Company. G. FRACTIONAL SHARES. No fractional shares shall be issued under the Plan. Any fractional shares which, but for this subparagraph G, would have been issued to an optionee pursuant to an Option, shall be deemed to have been issued and immediately sold to the Company for their fair market value, and the optionee shall receive from the Company cash in lieu of such fractional shares. H. ADJUSTMENTS. Upon the happening of any of the events described in subparagraphs A, B or C above, the class and aggregate number of shares set forth in paragraph 4 hereof that are subject to Stock Rights which previously have been or subsequently may be granted under the Plan shall also be appropriately adjusted to reflect the events described in such subparagraphs. The Committee shall determine the specific adjustments to be made under this paragraph 13 and, subject to paragraph 2, its determination shall be conclusive. 14. MEANS OF EXERCISING OPTIONS. An Option (or any part or installment thereof) shall be exercised by giving written notice to the Company at its principal office address, or to such transfer agent as the Company shall designate. Such notice shall identify the Option being exercised and specify the number of shares as to which such Option is being exercised, accompanied by full payment of the purchase price therefor either (a) in United States dollars in cash or by check, (b) at the discretion of the Committee, through delivery of shares of Common Stock having a fair market value equal as of the date of the exercise to the cash exercise price of the Option, (c) at the discretion of the Committee, by delivery of the optionee's personal recourse note bearing interest payable not less than annually at no less than 100% of the lowest applicable Federal rate, as defined in Section 1274(d) of the Code, (d) at the discretion of the Committee and consistent with applicable law, through the delivery of an assignment to the Company of a sufficient amount of the proceeds from the sale of the Common Stock acquired upon exercise of the Option and an authorization to the broker or selling agent to pay that amount to the Company, which sale shall be at the participant's direction at the time of exercise, or (e) at the discretion of the Committee, by any combination of (a), (b), (c) and (d) above. If the Committee exercises its discretion to permit payment of the exercise price of an ISO by means of the methods set forth in clauses (b), (c), (d) or (e) of the preceding sentence, such discretion shall be exercised in writing at the time of the grant of the ISO in question. The holder of an Option shall not have the rights of a shareholder with respect to the shares covered by such Option until the date of issuance of a stock certificate to such holder for such shares. Except as expressly provided above in paragraph 13 with respect to changes in capitalization and stock dividends, no adjustment shall be made for dividends or similar rights for which the record date is before the date such stock certificate is issued. 15. TERM AND AMENDMENT OF PLAN. This Plan was adopted by the Board in July 1997 and by the stockholders of the Company on September 9, 1997. The Plan was amended on March 12, 1998 to increase the number of shares authorized for issuance under the Plan by 750,000 shares to 1,500,000, and such amendment was approved by the stockholders of the Company at the Annual Meeting held on April 30, 1998. On March 1, 1999, the Board of Directors further amended the Plan to increase the number of shares authorized for issuance under the Plan by 1,000,000 shares to 2,500,000 shares and to make certain other minor modifications, subject to approval of the amendment of the Plan by the stockholders of the Company at the next Meeting of Stockholders. If the approval of the amendment by the stockholders is not obtained prior 7 8 to March 1, 2000, any grants of ISOs under the Plan which include shares from the additional number of shares authorized by the amendment made prior to that date but subsequent to the date of the amendment will be rescinded. The Plan shall expire at the end of the day on October 15, 2007 (except as to Options outstanding on that date). Subject to the provisions of paragraph 5 above, Options may be granted under the Plan prior to the date of stockholder approval of the Plan. The Board may terminate or amend the Plan in any respect at any time, except that, without the approval of the stockholders obtained within 12 months before or after the Board adopts a resolution authorizing any of the following actions: (a) the total number of shares that may be issued under the Plan may not be increased (except by adjustment pursuant to paragraph 13); (b) the provisions of paragraph 3 regarding eligibility for grants of ISOs may not be modified; (c) the provisions of paragraph 6(B) regarding the exercise price at which shares may be offered pursuant to ISOs may not be modified (except by adjustment pursuant to paragraph 13); and (d) the expiration date of the Plan may not be extended. Except as otherwise provided in this paragraph 15, in no event may action of the Board or stockholders alter or impair the rights of a grantee, without such grantee's consent, under any Stock Right previously granted to such grantee. 16. MODIFICATIONS OF ISOS; CONVERSION OF ISOS INTO NON-QUALIFIED OPTIONS. Subject to paragraph 13(D), without the prior written consent of the holder of an ISO, the Committee shall not alter the terms of such ISO (including the means of exercising such ISO) if such alteration would constitute a modification (within the meaning of Section 424(h)(3) of the Code). The Committee, at the written request or with the written consent of any optionee, may in its discretion take such actions as may be necessary to convert such optionee's ISOs (or any installments or portions of installments thereof) that have not been exercised on the date of conversion into Non-Qualified Options at any time prior to the expiration of such ISOs, regardless of whether the optionee is an employee of the Company or a Related Corporation at the time of such conversion. Such actions may include, but shall not be limited to, extending the exercise period of such ISOs. At the time of such conversion, the Committee (with the consent of the optionee) may impose such conditions on the exercise of the resulting Non-Qualified Options as the Committee in its discretion may determine, provided that such conditions shall not be inconsistent with this Plan. Nothing in the Plan shall be deemed to give any optionee the right to have such optionee's ISOs converted into Non-Qualified Options, and no such conversion shall occur until and unless the Committee takes appropriate action. Upon the taking of such action, the Company shall issue separate certificates to the optionee with respect to Options that are Non-Qualified Options and Options that are ISOs. The Committee, with the consent of the optionee, may also terminate any portion of any ISO that has not been exercised at the time of such conversion. 17. APPLICATION OF FUNDS. The proceeds received by the Company from the sale of shares pursuant to Options granted and Purchases authorized under the Plan shall be used for general corporate purposes. 18. NOTICE TO COMPANY OF DISQUALIFYING DISPOSITION. By accepting an ISO granted under the Plan, each optionee agrees to notify the Company in writing immediately after such optionee makes a Disqualifying Disposition (as described in Sections 421, 422 and 424 of the Code and regulations thereunder) of any stock acquired pursuant to the exercise of ISOs granted under the Plan. A Disqualifying Disposition is generally any disposition occurring on or before the later of (a) the date two years following the date the ISO was granted or (b) the date one year following the date the ISO was exercised. 19. WITHHOLDING OF ADDITIONAL INCOME TAXES. Upon the exercise of a Non-Qualified Option, the transfer of a Non-Qualified Stock Option pursuant to an arm's-length transaction, the grant of an Award, the making of a Purchase of Common Stock for less than its fair market value, the making of a Disqualifying Disposition (as defined in paragraph 18), the vesting or transfer of restricted stock or securities acquired on the exercise of an Option hereunder, or the making of a distribution or other payment with respect to such stock or securities, the Company may withhold, or may require the grantee to pay, additional withholding taxes in respect of amounts that constitute compensation includible in gross income. The Committee in its 8 9 discretion may condition (i) the exercise of an Option, (ii) the transfer of a Non-Qualified Stock Option, (iii) the grant of an Award, (iv) the making of a Purchase of Common Stock for less than its fair market value, or (v) the vesting or transferability of restricted stock or securities acquired by exercising an Option, on the grantee's making satisfactory arrangement for such withholding. Such arrangement may include payment by the grantee in cash or by check of the amount of the withholding taxes or, at the discretion of the Committee, by the grantee's delivery of previously held shares of Common Stock or the withholding from the shares of Common Stock otherwise deliverable upon exercise of a Option shares having an aggregate fair market value equal to the amount of such withholding taxes. 20. GOVERNMENTAL REGULATION. The Company's obligation to sell and deliver shares of the Common Stock under this Plan is subject to the approval of any governmental authority required in connection with the authorization, issuance or sale of such shares. Government regulations may impose reporting or other obligations on the Company with respect to the Plan. For example, the Company may be required to send tax information statements to employees and former employees that exercise ISOs under the Plan, and the Company may be required to file tax information returns reporting the income received by grantees of Options in connection with the Plan. 21. GOVERNING LAW. The validity and construction of the Plan and the instruments evidencing Stock Rights shall be governed by the laws of the Commonwealth of Massachusetts, or the laws of any jurisdiction in which the Company or its successors in interest may be organized. 9 EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 1 7,913 51,103 7,706 590 0 608 6,793 2,024 71,508 17,153 0 0 0 73,525 (19,170) 71,508 22,857 28,590 1,045 3,525 18,131 0 1,456 8,390 3,188 5,202 0 0 0 (5,202) .36 .36
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